Our Business Transactions team has worked on a wide range of M&A deals. This is the second post in a series that discusses some of the key issues buyers and sellers will encounter during the M&A process, and some of the lessons we have learned along the way.
Buying or selling a business is a significant undertaking, and one you want to get right, whether you are the buyer or the seller. Determining the appropriate structure – whether the buyer is buying shares or assets – is critical to a successful transaction.
As a rule of thumb, sellers prefer share sales and buyers prefer asset sales. Here are five of the key considerations why:
With a share sale, all of the assets and liabilities of the target company remain with that company. This means that (subject to any agreed price adjustments or indemnifications) the seller gets to walk away from any liabilities and the buyer takes them on.
An asset sale allows the buyer to cherry pick which assets it will purchase and which liabilities it will assume. However, by law, the buyer will become liable for environmental contamination and for union employees in an asset transaction.
In an asset sale, non-union employees need not be taken on by the buyer, though commonly the seller will require the buyer to offer new contracts to all or most employees on terms that are substantially similar or identical to their existing contracts (including a recognition of prior service) so the vendor avoids wrongful dismissal claims from the employees.
In a share sale, the target company’s employees remain employed by the company, unless a change of ownership triggers rights under the employment agreements of certain employees such as senior executives. Therefore, unless the target company terminates certain employees and pays severance pay before closing, the target company retains all of the employees, even those the buyer does not wish to employ.
3. Reduced Complexity
Share sales are commonly less complex than asset sales: An asset sale will require transfer documentation for all of the assets being transferred (real property, permits and licences, leases, contracts, equipment and vehicles, intellectual property, etc.).
By contrast, under a share sale, all of the assets of the target company remain with the company. The only required transfer is of the shares of the company itself (and possibly an assignment of shareholder loans).
An asset sale may trigger the need to obtain more third party consents to the transfer of the assets (which can be a time consuming and expensive process) than would a share sale, where identifying and dealing with any change of control provisions in contracts, leases, licences and permits can be less burdensome. In addition, it may be that certain assets, such as government licences and permits, are not assignable.
4. Tax Considerations – Share Sale
The proceeds of a share sale (above the seller’s adjusted cost base) are taxed as capital gains, meaning only 50% is included as income.
If certain conditions are met, a $800,000 lifetime capital gains exemption (indexed to inflation) is available to Canadian residents who sell shares of a qualified small business corporation .
A corporate seller may be able to reduce its taxable gain by causing the target company to pay a non-taxable inter-company dividend from “safe income” (that portion of retained earnings attributable to earnings reported for income tax purposes) before the sale. The purchase price will be reduced accordingly.
A buyer might prefer a share transaction in order to take advantage of the target company’s non-capital tax-loss carryforwards (i.e. business losses) that can be applied against future income.
A share purchase allows a buyer to avoid paying sales and property transfer taxes on purchased assets. These taxes can be significant – property transfer tax is 1% on the first $200,000 in value of the real estate and 2% thereafter. Sales tax is 7%, although an exemption may be available in respect of certain assets such as production machinery and equipment.
5. Tax Considerations – Asset Sale
A seller will usually want the purchase price allocated to minimize the recapture of capital cost allowance previously deducted on depreciable property.
A buyer will usually want to allocate as much of the purchase price as possible to depreciable property so that it can ‘step up’ the value of assets to their fair value resulting in higher tax deductions for depreciation expenses in the future.
Lastly, a buyer will be required to pay property transfer tax on real property and buildings (including permanently affixed equipment) and sales tax on equipment and inventory (subject to any available exemptions).